Tag Archives: Warren Buffet

The Wizard of Omaha Pt.2

Warren Buffett noticed that because Graham got rid of the stocks so quickly, many of his “undervalued stocks” stayed undervalued. A handful of companies that Graham and Warren purchased that were sold under the 50% rule continued to grow and prosper year after year. The prices went up way above where they had been when Graham sold them.

As a result, Warren studied the financial statements of the companies that performed well. Warren learned that these all stars all shared the following strengths:

1) They sell a unique or service

2) They are the low-cost buyer and seller of a product

Selling a unique product: Coca-Cola. The producers of these products have placed the stories of their products in our minds. When you hear someone open up a Coke bottle, you think of a remedy of thirst.

Selling a unique service: Moody’s Corp. People need the services and are paying for it. It is instituational specific, and not people specific. A company does not have to spend big bucks redesigning its products.

Being the low-cost buyer: Nebraska Furniture Mart in Omaha. It is the low-cost buyer and seller. Their margins are traded for volume. The great volumes makes up for any decrease in margins.

These wonderful business attributes work in the companies’ favour, and there is very little chance of them going bankrupt.

Warren came up with the idea that one would purchase these stocks with such attributes and hold onto them faithfully.

Continue reading

Financial Weapons of Mass Destruction: A Look At How Derivatives Work

Warren Buffett has once officially declared derivatives as “financial weapons of mass destruction”.

Derivatives? Oh no, I am not talking about high school calculus.

The Basics

A financial derivative that is a security that “derives” its value from another item or value. The most traditional derivatives are stock options, futures, forwards and swaps. However derivatives come in all shapes and sizes, and most recently we have seen something like Collateralized Debt Obligations or CDOs in the US and European markets.

CDOs were popular with bankers in the 2000’s, however they did not understand the risk associated with the instruments and losses can mount up as high as St.Agnes. CDOs are essentially any loans with a bundle of assets attached to them, which in the 2007 market debacle, were mortgages on houses.  The loan and the asset are usually grouped together and sold as a single instrument.

Traditional derivatives are more tried and true, hence they are more reliable to certain extent.

Options give owners the right to buy something at a certain value at a certain point in time.

Futures and forwards give investors the right to buy something at a certain value at a later date. A grape farmer can sell next year’s harvest by visiting the futures or forwards markets to someone who is willing to buy at a price set in advance (a counterparty). Terms for futures are standardized, unlike forwards. Future contracts correspond to other contracts, hence they can be traded on exchanges globally.

Continue reading

Win, Lose or Vanish. A Diagnosis of the Psychology of Investing Through the Art of Card Playing

Luck was a servant and not a master. Luck had to be accepted with a shrug or taken advantage of up to the hilt…Bond saw luck as a woman, to be softly wooed or brutally ravaged, never pandered to or pursued…

Casino Royale – by Ian Fleming

Although lifted from a fictional adventure of 007, created by Ian Fleming, the above quote vividly illustrates how a gentleman should tango with Lady Luck; whether you are betting on the stock market or on the green velvet card table in Monte Carlo.

Many people may believe that betting in a card game is risky and highly dependent on the mood of Lady Luck. However, a layman investor may be making the same mistakes as an oblivious gambler.

A game like Poker is in fact a perfect simulation of what goes on in the grand scheme of the investment universe. The same emotional traps set at the card table are very well the same traps that devour many investors.

Let us examine the vices of investors by using the game of Poker as a referential case study.

Vice #1 Future can be predicted

Card players like to predict what cards will turn up next based on cards already shown on the table. This is the same mistake as how investors become overly optimistic based on past information about a stock or a fund.

If a card player is trying to make a flush (five cards of the same suit) and he is holding two hearts with two others showing as community cards on the table, the card player is very tempted to think the next card turning up would be heart. However, hearts are only one of the four suits, and his odds are in reality less than 18.75%  (given one deck of cards, and no other players). Four hearts have already turned up, so in the deck of cards, only nine more hearts are present.

Similarly, emotional investors are overly optimistic about past winners and overly pessimistic about past losers. Certain investments, especially mutual funds, are advertised with high historical returns which may not have any impact on the future returns. Certain stocks also meet the criteria of investor emotional bias, e.g common stock of Ford Motor Co. was trading @ $1.43 in 2008, with a recent high of $12.51, and not much has changed in the fundamentals of the company, only the emotions are stabilized.

When investing with a portfolio, one must examine the long term. Examine the 10 year or 8 year history, and not just how the stock or fund performs in the past couple of years. For a fund, examine the fund size, fees, turnover, and manager tenure. For mutual funds, an investor must be diligent in conducting their research regarding the funds that have been closed by the company. Mutual funds with consistent losses are closed and do not show in the historical rate of return as presented in the pamphlets.

For a stock, look at the inherent value of the company, just like good old Mr. Buffett would. Do not invest in a stock just because the price has been rising. “Value Investing”, anyone?

Trying to form a pattern based on random past information is as reliable as a naïve woman trying to predict your future by reading horoscopes. If you still believe in horoscopes, then perhaps you should never be allowed to approach the card table at Monte Carlo or the stock market. Please go back to watching the “Twilight” series.

Continue reading